Implementing Risk Management in Emerging Markets Risk Management in Emerging Markets Bhaskar...

Implementing Risk Management in Emerging Markets

Bhaskar Majumdar

Chief Risk Officer

The Industrial Bank of Kuwait

Global Association of Risk Professionals

August 2014

2

Agenda

Opening

Presentation

Q&A

FRM & ERP Recognition Ceremony

Closing

Networking

3

The views expressed in the following material are the

author’s and do not necessarily represent the views of

the Global Association of Risk Professionals (GARP),

its Membership or its Management.

4 | © 2014 Global Association of Risk Professionals. All rights reserved.

Emerging markets – The Context

It is risky to lump Emerging Markets into one uniform asset class.

The economic systems, political systems, infrastructure and market structures vary greatly from one

EM to another and can be significantly different from the standards of developed economies and

markets.

EM Risks are higher, but the rewards, given a reasonable time frame, could be significantly greater.

Useful to look at emerging markets, institutions and risks within an interlinked global framework.

Unfortunately, a common global approach and cooperation is lacking at present. Individual country

approaches such as the US QE adds and magnifies emerging market risks and encourages short

term views.


The Emerging Market Environment --- What are we looking for?

Strong economic development and moving from closed economy with overarching state control

towards open markets and integration with the world economy.

Undergoing institutional and bureaucracy reforms with accountability, transparency and increased

market efficiency.

Liquid Equity and debt markets, Exchanges and Regulatory bodies.

A stable exchange rate system.

Increasing Foreign Direct and Portfolio investments.

Higher returns and yields compared to developed markets given reasonable time horizons.

These economies are rapidly changing and always in a state of flux.

Financial markets might be particularly volatile and risks need to be carefully managed.


Risks in the Emerging Markets

Significant political risks,

Shallow markets, lower market efficiency, information flows and transparency.

Hedging constraints.

Shadow banking and payment mechanisms.

Existence of state monopolies.

Underdeveloped infrastructure, though some Frontier markets might have better infrastructure (e.g.

GCC) than the top emerging markets.

Currency volatility due to internal and external factors. QE has added to EM risks.

Limited equity opportunities.

Market access and repatriation restrictions.

Strong inward looking and bureaucratic regulatory framework – command and control.

Politically motivated lending and NPLs.

Lack of trustworthy data and information.

Lack of effective hedging mechanisms.

These tend to improve over time, sometimes due to external shocks or internal political compulsions.


State of Risk Management in Banks and Financial Institutions

Given these circumstances where risks ebb and flow, risk management should logically get significant

attention. Think again.

Though difficult to generalize, it is slowly making some headway with resistance from within existing

institutional structures.

There are many approaches to risk management though the Basel approach is becoming standard due to the

strong push by the regulatory authorities.

Thus initially, risk management in most Banks started as a regulatory compliance function with the prime

objective of regulatory reporting to the Central Banks.

Many were under the Financial Control Function.


Risk Management Grows Despite Resistance.

Compliance

Control Reviews

Risk Analysis,

Measurement,

Assessment

Integrated Risk

Management – Risk

Culture

1. Band Aid 2. Reactive 3. Proactive 4. Integrated Approach

• Treating symptoms

•Crisis investigation

•Crisis prevention

•Control Analysis

• Treating problems

•Cause Analysis

•Risk System Design

•Reporting

•Risk Appetite

•Risk Policy

•Risk Culture

•Common Wavelength

•Risk integrated with

Business Strategy

•Risk Adjusted Returns

•Economic Capital

•KRI, predictability

•Risk Monitoring

•Risk Disclosure


Ground Zero

Though risk was intuitively understood, in a relatively stable world, risk was to be avoided, not embraced.

That individual human judgment was supreme and that judgment led to binary yes/no, good/bad decisions.

That judgment was necessarily based on historical data linearly projected forward and the past was the only

guide to the future.

A formal risk management function was considered superfluous as good audit departments did the job

anyway. No one wanted another ‘control’ function.

Some tension between the credit selling units and independent credit assessment was evident and more of

such tension was considered avoidable.

Market risk was managed through various trading limits and oversight.

Operational risk was gradually formalized .

The approach to Risk management was silo based.

Risk Managers faced credibility issues. This is where risk qualifications like the FRM helped.


Risk Management and Corporate Governance - The Symbiosis

In complex risk-taking organizations, it’s not really possible to separate best-practice risk management from

best-practice corporate governance.

Boards can’t monitor and control the financial condition of a risk taking institution without excellent risk

management and risk metrics.

The risk management function depends on sponsors at the senior executive and board level to gain the

investment it requires, and the influence it needs to balance out powerful business leaders

Everything should flow from a clear and agreed-upon risk management policy at the top. Without this kind of

platform, it’s difficult for risk managers further down the management chain to make key decisions on how they

approach and measure risk.

The evolution of risk management has a significant influence on the evolution of Corporate Governance as it is

its most critical tool.


The State of Pre-Crisis Corporate Governance – McKinsey International Survey

Survey response from 200 directors, who sat on 500 boards. Two-thirds of the respondents were from

companies with $1 billion or more in revenues or market-cap.

Risk management. More than 40 percent of those surveyed did not have effective processes for identifying,

safeguarding against, and planning for key risks; almost one-fifth had no process at all. Strategic decisions made in

the absence of a formal assessment of the risks associated with the various strategic options.

Oversight of chief risk officer. More than a quarter of directors with a financial/risk perspective have concerns

about the way the board conducts its oversight of the CRO, and 60 percent have not even observed the nature of

this oversight.

Compensation. Insufficient focus on how the corporation’s chosen compensation policy might drive corporate

strategy, and the effect this might have on achieving the corporation’s preferred risk profile.

Understanding the business. Over 40 percent of directors admitted that they did not have a full understanding of

where the value of the business is created. When asked to rate their colleagues, directors believe that almost half

are low or average performers.

Non Disclosure to Board. Information from management to Board could be doctored; complexities of

transactions involving financial engineering not understood. Non disclosure of economic risks.

Director independence. Directors believed that more than a quarter of their nonexecutive director colleagues

should not be considered truly independent.


The State of Post-Crisis Corporate Governance: Middle East

• The global financial crisis emphasized and brought the role of poor corporate governance into focus (Central

Bank observation).

• Boards fell short in taking responsibility for guiding strategic objectives, organization structures, financial

soundness and safeguarding the interests of all stakeholders.

• There was little or no focus on Risk Management and it was largely and incorrectly treated as a Compliance

issue.

• Traditional reliance on the Board Audit Committee and the assumption that Audit was enough to manage

risk.


The State of Post-Crisis Risk Governance: Middle East

• CRO positions, if created, largely reported to the CEO and thus competed for attention with other

business heads. Effectiveness substantially reduced.

• Name lending was rampant and undue influence and conflict of interest was common.

• Board members with expertise in banking and financial business were few and hard to find, and so were

qualified board secretaries.

• Managements could provide Boards with misleading information.

• Breakdowns in the process of transmission of critical information to Board and shareholders and lack of

transparency.

• In many cases, Finance and MIS units under them controlled BI information and Risk Management was

yet to get direct access to BI. Assessing pure ‘returns’ and ‘not risk adjusted returns’ was the norm.


Current Status: Risk Governance – Gulf Cooperation Council (2013-2014)

• Basel Guidelines on Corporate Governance are being implemented all across the GCC, though led by Central

Banks. Imposed enlightenment.

• Special Board sub committees are compulsory : Corporate Governance Committee, Nominations Committee,

Remuneration Committee, Risk Committee and Audit Committee.

• Separation of the roles of Chairman and CEO. CRO reporting to the Chairman or the Board Risk Committee.

• CRO cannot be fired without approval from Board and Central Bank. ( Ha! )

• Linking remuneration with performance and risks time lined to the long run with claw backs, expansion of

disclosure criteria, and transparency of the legal and regulatory structures of banks to enable enhanced Risk

Management.

• Special role of the Board Risk Committee – Determination of Risk Appetite. Risk Limits. Risk Infrastructure.

Budgetary, political and moral support.

• Risk data aggregation BI – under consideration – work in progress.


Compliance challenges - FATCA

• Foreign Assets Tax Compliance Act - USA. Raise revenue by curbing offshore tax evasion by ‘US Persons’.

• Requires Banks, Funds and other FIs around the world to report assets held by American clients, or face a 30%

withholding tax on earnings via the US.

• Requires registration with the US IRS, either individually or through an intergovernmental agreement.

• Outsource financial policing. FATCA turns foreign banks and FIs into enforcement arms of the US IRS. This

extends to collecting data and reporting on recalcitrant customers, both retail and corporate.

• Requires IT Systems support, Creation of FATCA database and information collections and reporting modules,

enhancement of KYC questionnaires.

• Costs of compliance are borne mostly by foreign banks and institutions who are not reimbursed by the IRS for

services rendered or infrastructure set up.

• Debates on jurisdictional issues and the obnoxious nature of an imposed foreign law.

• Confusion about who is a financial institution and the definition of a ‘US person’ can be broad. There are large

numbers of people in the Middle East with dual citizenship. It extends to green card holders and people with US

Contacts. Tough to get buy in from customers.

• 80 countries on hopes of reciprocity and 77,000 institutions have signed up. Serious privacy issues.

• Drug dealers and sophisticated tax evaders will switch to non financial assets.

• May encourage a move away from dominance of the US Dollar over a period of time.


Risk BI Intelligence and Data Aggregation

14 Basel Principles for Effective Risk Data Aggregation and Risk Reporting (http://www.bis.org/publ/bcbs239.pdf Jan2013)

• A significant lesson learnt from the global financial crisis was that banks’ information technology (IT) and dataarchitectures were inadequate to support the broad management of financial risks.

• Many banks lacked the ability to aggregate risk exposures and identify concentrations quickly and accurately at thebank group level, across business lines and between legal entities.

• Some banks were unable to manage their risks properly because of weak risk data aggregation capabilities and riskreporting practices. This had severe consequences to the banks themselves and to the stability of the financialsystem as a whole.

• Improving their risk data aggregation capabilities strengthen the capability and the status of the risk function to makejudgments.

• This leads to gains in efficiency, reduced probability of losses and enhanced strategic decision-making, and ultimatelyincreased profitability.

• The Basel Principles cover four closely related topics: Overarching governance and infrastructure, Risk dataaggregation capabilities, Risk reporting practices, Supervisory review, tools and cooperation (Compliance).Completely in line with best practice Corporate Governance objectives.

• Though targeted at Systematically Important Banks (SIBs) – to be compliant by 2016, regulators around the worldhave taken this up in their jurisdictions.

• There are implications on how Business Intelligence is now collected and distributed, as also IT system issues suchas creation of integrated data bases with the help of data warehouse and structured access control.

http://www.bis.org/publ/bcbs239.pdf


The way forward

• Risk Management in the emerging markets is in a constant state of flux and change.

• Increasing regulatory interventions and oversight.

• Thinking out of the box for credit, liquidity, market and operational risks.

• The need to communicate internally at all levels and externally with regulators and industry bodies.

• Continuously update risk knowledge and look for things that work well in local situations.

• Many Risk Professionals tend to be brainy, analytical and introverted.

• The need is to interact at all levels with confidence and these ‘soft skills’ need to be developedand encouraged. A bit of self assured extroversion may not be a bad thing while operating inour markets.

COMMUNICATE COMMUNICATE COMMUNICATE

THANK YOU


Q & A


FRM & ERP

Recognition Ceremony


Networking

C r e a t i n g a c u l t u r e o f

r i s k a w a r e n e s s ®

Global Association of

Risk Professionals

111 Town Square Place

14th Floor

Jersey City, New Jersey 07310

U.S.A.

+ 1 201.719.7210

2nd Floor

Bengal Wing

9A Devonshire Square

London, EC2M 4YN

U.K.

+ 44 (0) 20 7397 9630

www.garp.org

About GARP | The Global Association of Risk Professionals (GARP) is a not-for-profit global membership organization dedicated to preparing professionals and organizations to make

better informed risk decisions. Membership represents over 150,000 risk management practitioners and researchers from banks, investment management firms, government agencies,

academic institutions, and corporations from more than 195 countries and territories. GARP administers the Financial Risk Manager (FRM®) and the Energy Risk Professional (ERP®)

Exams; certifications recognized by risk professionals worldwide. GARP also helps advance the role of risk management via comprehensive professional education and training for

professionals of all levels. www.garp.org.


Date post:	24-May-2018
Category:	Documents
Upload:	lamcong
View:	217 times
Download:	1 times

Implementing Risk Management in Emerging Markets Risk Management in Emerging Markets Bhaskar...

Documents